OK, This Carrier Subsidy Problem May Be A Real Concern For Apple's Stock

Apple’s stock has pulled back sharply in recent weeks, falling ~10% from a high of $645 to $570.This is in part due to the spectacular moonshot the stock enjoyed during the fall and winter, when it blasted from $400 to nearly $650. Apple’s stock has often sold off after moves like this, and the current pullback may be just more of that behaviour.

But, still, a change in trend like Apple’s may indicate a fundamental concern. And these fundamental problems often start small and grow in importance over time, dragging the stock down with them.

So it’s worth thinking about what investors might be worried about.

There are still a couple of catalysts that could drive Apple’s stock higher this year, namely the launch of the iPhone 5 and the expected debut of the full-fledged Apple TV in the fall. But analysts have begun backing away from the expected launch date of the TV in recent weeks, which may be having some impact.

And there’s the broader and more profound concern that, by 2013, Apple’s new products will no longer benefit from the firsthand influence of Steve Jobs. Steve worked right up until he died last year, and he likely had a significant influence on this year’s product releases. Next year, that won’t be the case, and Apple’s team will have to demonstrate that it can create the same product magic without Steve.

Both of those are real concerns, but a more immediate one may be this: A concerted effort among some of the world’s telecom carriers to reduce the level of handset subsidies that they’re giving consumers.

Carriers are adding or increasing upgrade fees for consumers who want to switch phones. AT&T and Sprint doubled their fee to $36, and Verizon now charges $30.

Carriers are increasing monthly data subscription rates. All else being equal, this means customers will have less money to spend on new phones.

In Spain, two of the leading wireless companies–Telefonica and Vodafone–have stopped subsidizing handsets for new customers. Instead, they’re focusing on retaining their existing customers, for whom they do offer subsidies. This will reduce their spending on device subsidies by 25%. (A third operator, Orange, still offers subsidies, and is trying to use this opportunity to gain share. Carriers the world over are watching closely).

The stocks of some of the big wireless providers have risen in recent months, while Apple and Google have fallen. This suggests that the market may be concerned about a change in the power balance here.

It’s important to understand two things here:

First, the iPhone now accounts for more than 50% of Apple’s revenues (see chart above). So any change in the growth trajectory of the product line will have a big impact on the company’s performance.

Second, carriers do not need to eliminate subsidies for there to be a negative impact on the velocity of iPhone sales. Carriers merely have to discourage rapid upgrades and encourage existing customers to keep phones longer.

On this second point, it’s worth making a final observation:

The dumbphone conversion cycle–click for more.

The rate at which each generation of iPhones (and other smartphones) improves over the prior generation is slowing. As a result, the benefit to consumers of upgrading to the latest, greatest phone becomes smaller and smaller.(As an example, I’m still using an iPhone 3GS. I’d certainly like to have a a 4 or 4S or 5, and I’ll probably get one eventually. But there’s really no rush. The 3GS is excellent. And the software and app upgrades keep improving it without my ever having to upgrade.)

There is still massive growth left in the global smartphone market. The “dumbphone conversion cycle,” in which 6 billion cell phones will be converted to smartphones, is still in its early stages. And Apple is still in an excellent position, in part because of the failure of Google to fix the problems with Android.

But the better smartphones get, the less consumers will feel the need to upgrade to a new one every year. And the eagerness to upgrade will be dampened further if carriers really get serious about trying to kick the subsidy addiction.

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